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Sunday, Dec 21, 2003

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Software acquisitions — Discretion to dictate deals

Krishnan Thiagarajan

"Going global" through overseas acquisitions is the flavour for India Inc. over the past few months. This week, it was the turn of the software sector to jump on to the bandwagon, breaking the spell of inactivity on the acquisitions front by frontline companies.

The previous acquisition of note by a frontline company was Wipro's buy of US-based Nervewire Inc in April. Two companies from across the software spectrum — Infosys Technologies from the software services space and i-flex solutions from the products space — unveiled their maiden acquisitions — of Australia-based Expert Information Services and US-based SuperSolutions respectively. The media buzz surrounding the Infosys deal was particularly high, given the fact that it was its first acquisition made after listing its ADR on Nasdaq in 1999 to help explore inorganic growth options. But the stock market appeared lukewarm to these deals, with the stocks hardly budging on the day of announcement. The uptrend in the Infosys stock on Friday was largely a reflection of the bullish sentiment across Sensex heavyweights, rather than any stock-specific activity. In the backdrop of these deals, two key trends can be collated for the future:

Presaging a trend?

The Infosys acquisition may not be suggest a trend in the software services arena. This becomes evident from the fact that Infosys sifted 135 candidates over the past four-and-half years to find the right match this week. Though the company has been sitting on $470 mllion in cash and equivalents (including investments in liquid mutual units) in its balance-sheet, less than 5 per cent of it is to be used for making this acquisition. Finding the "right fit", proper due diligence of the target company and financial prudence will continue to dictate Infosys' future acquisition strategy.

Second, it cannot be said that competitive pressures were at play driving Infosys to make this deal. Wipro, its closest competitor, had announced four acquisitions — two each at home and abroad over the past 12-15 months. And the last deal by Wipro involving Nervewire Inc was put through in April. Moreover, the size of the Infosys deal at $22.9 million (relative to $18.7-million Wipro-Nervewire deal or $11.5million of i-flex solutions) is fairly small. This may hardly change the competitive dynamics for frontline companies such as Satyam Computers and HCL Technologies to press the panic button on the strategic front. The only signal that Infosys has sent out is that it will not be averse to acquisitions when the company offering the right match at the right price comes along.

Integration challenges

Going by the merger and acquisition (M&A) experience in the software arena, Indian software companies, be it frontline or medium sized, are acutely conscious of the challenges of integration and employee retention issues.

The record of the medium-sized Indian software companies has been mixed. For every successful acquisition, there have been instances of prolonged integration problems, while others have led to financial problems. Take for instance, Silverline Technologies' acquisition of e-business consulting firm, Seranova Inc. US in 2000/01. Practically, all the financial problems that have bedevilled Silverline since then could be linked in some way to this ambitious acquisition.

Leave alone overseas acquisitions, medium sized companies have had a tough time putting together M&As between two domestic entities. Take the case of Polaris Software. Its merger with Orbitech Solutions, the technology subsidiary of Citigroup, first announced in May 2002, ran into a multitude of problems relating to integration of the two work cultures. By October 2002, the stock swap ratio had to be changed and Polaris faced sustained challenges on the employee front. Though some signs of stability in the financial performance have been seen in the recent quarters, sustained benefits from the merger will take time to get fully reflected in the financials. Ultimately, the success of any M&A exercise itself takes at least a year or two to pan out. As Cisco's CEO, Mr John Chambers, said, "In the average acquisition, 40 to 80 per cent of the top management and key engineers are gone in two years. I would measure the success of my acquisitions through retention of people and revenue that you generate two or three years later."

It is hardly surprising that Infosys has structured its latest deal with milestone payments every year subject to the certain financial and key employee retention targets being met.

And since no foolproof formula has been evolved for managing the integration, a cautious approach to M&A will remain the norm.

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